Title: OUTLINE FOR CHAPTER 21
1OUTLINE FOR CHAPTER 21
- Understand Repositioning of Funds
- Constraints on Moving of Funds
- Ways to Transfer Funds
- Unbundling
- What to do if Funds are blocked
- Aspects of Working Capital Management
- Advantages and Disadvantages of a Centralized
Depository - Netting (bilateral and multilateral)
- Accounts Payable vs. Short-Term Debt
2Chapter 21 Working Capital Management
- Managing current assets and current liabilities
as well repositioning funds. - Repositioning funds - Moving Funds from one
country to another or from one currency to another
3Why Reposition Funds
- For tax Reasons- locate profits in low-tax
environments - To move funds to areas with greater profit
potential - To move funds out of areas of economic or
political problems - To move funds from countries that have exchange
controls
4Constraints on Positioning Funds
- Usually assumed for a domestic firm there is no
problem in moving funds from one affiliate to
another - However for multinational firms there are often
problems in moving funds
5Constraints - Continued
- 1) Political (examples - inconvertible currency,
exchange controls and dividends and other
remittances heavily taxed or limited in amount) - 2) Taxes (example withholding)
- 3) Transaction costs (small / unit but add up
over a year) - 4) Liquidity needs (banks want firms to keep a
portion of their funds at their banks)
6Unbundling
- Many firms transfer funds in many ways (unbundle
the package) as opposed to transferring funds in
only one way (often through dividends) - It may be more acceptable politically to transfer
funds in multiple ways (a firm would not want to
make too large of a dividend payment)
7Ways to Transfer Funds
- 1) Dividends
- 2) License fees, royalties, overhead and loans
- 3) Transfer pricing
- 4) Leads and lags (discussed earlier)
8Dividends - Considerations
- 1) Taxes - complicated
- withholding taxes
- in Germany, different tax rates on retained vs.
distributed earnings (which are lower) - countries have different tax rates
- countries often give tax credits for foreign
income taxes
9Dividend Considerations - Continued
- 2) Political risk (for example, if a host country
is very risky the parent may want more dividends
declared by the subsidiary) - 3) Impending devaluation (would want subsidiary
to speed up payables to the parent) - 4) Availability of funds (are the funds available
to declare a dividend)
10Dividend Considerations - Continued
- 5) Joint venture partner (presence of a partner
may dictate a defendable dividend policy - joint
venture partner will want his/her proper share of
the profits)
11Royalties, Fees, Overhead and Loans -
Considerations
- A parent can charge its subsidiaries for the use
of technology, patents, trade names etc. - Funds can effectively be transferred by over or
undercharging from their true cost - Royalties, fees, etc. are usually locally tax
deductible while dividends are not tax deductible
12Transfer Pricing
- Price one unit of a company charges another unit
of the company for goods or services - The higher the price the more money the unit
keeps and if the amount is above the true price
this would amount to a transfer of funds - A major consideration for transfer pricing in
addition to positioning of funds is the income
tax effect
13Example of Income Tax Effect on Transfer Pricing
- Parents tax rate - 40
- Subs tax rate - 30
- Parent buys finished goods from the sub
- Parent sells one good for 200
- Cost of goods sold for one unit is 100
14Example - Transfer Price of 200(amounts in
dollars)
15Example Transfer Price - 100(amounts in dollars)
16Transfer Price Examples
- Principle All things being equal, want to show
as much profit as possible in country with the
lowest tax rates
17Transfer Pricing - Tax Considerations
- U.S. Section 482 suggest using an arms- length
price (price one independent unit would charge
another independent unit) - IRS - 3 methods to establish arms-length price
(in order) - Comparable uncontrolled prices (market price)
- Resale price method (final price - markup)
- Cost-Plus method (full cost markup)
18Other Considerations on Transfer Pricing
- 1) Tariffs (if a company pays a percentage of the
transfer price would want, all things being
equal, a low transfer price) - 2) Transfer pricing may make it difficult to
judge performance of subsidiaries - 3) Transfer price should be fair to joint venture
partner
19Blocked Funds
- Governments can limit transfers of foreign
exchange of the country (examples - prior
approval is needed to transfer and governments
can make a currency inconvertible)
20Moving Blocked Funds
- 1) Use techniques discussed earlier for moving
funds - 2) Fronting loans
- 3) Creating unrelated exports
- 4) Obtaining special dispensation (bargain for a
special deal with the local government)
21Fronting Loan
loan
Parent
Sub
International Bank
deposit
loan
Parent
Sub
22Fronting Loan - Continued
- Bank fronts for the company (note bank has 100
collateral) - A government will more likely allow payment under
the fronting loan than under the straight loan
because its reputation will be hurt more if it
does not allow a company to repay a major
international bank - In many cases bank may be from a neutral country
23Creating Unrelated Exports
- Examples
- Locate a RD facility in a country that blocks
funds (in this case pay expenses in local
currency) - Have a big party (again pay expenses in local
currency)
24Primary Purposes for Holding Cash Balances
- 1) Transaction needs
- 2) Precautionary reasons
25Centralized Depository
- Affiliates hold minimum cash for transactions and
none for precautionary purposes - Excess cash for each affiliate is remitted to
depository - Central depository invests excess funds for all
subs and borrows if needed
26Advantages of a Depository
- Information advantage
- the staff should know more about investment and
borrowing opportunities worldwide than the
financial manager at local subsidiary. - Also the more money they handle the better the
information they should be able to obtain. - Also being located in a major financial center,
it should have in general access to good and
timely information.
27Advantages - Continued
- Total precautionary balance for company as a
whole will be less than if each subsidiary holds
its own balances (portfolio effect) - With a depository should not run into the
situation that one sub is borrowing money (at a
high rate) while another sub is investing money
at a bank (at a low rate) - The depositories should locate in major money
centers or other places that have major
advantages.
28Disadvantage to the Centralized Depository
- It would require funds to set up and also to
continually maintain
29Netting
- The table on the next slide represents the
payment schedule for a month for a company with
four subsidiaries or one parent and three
subsidiaries - In this case sub C owes sub A 2 and sub A owes
sub C 3
30Paying Subsidiaries
Receiving Subsidiaries
31Netting - Continued
- The worst system would be for each sub to pay the
gross amount to all of the other subs (for
example sub A pays 3 to sub C and sub C pays 2
to sub A) - this would result in a total of 12
transactions - Better to have bilateral netting - for example,
sub A would pay sub C 1 (6 transactions)
32Netting - Continued
- If every sub paid or received from a central pool
there would be only four transactions - for
example, sub A would receive 1 from the pool - The best arrangement would be for the director of
the pool to tell sub B to pay sub A 1 and sub D
to pay sub C 2. This would involve only 2
transactions
33Netting - Continued
- Multilateral netting cuts down on the number of
transactions as well as the amount of each
transaction - Some countries dont allow netting (want to help
local banks)
34Accounts Payable vs. Short-Term Debt
- Many times a company (domestic or foreign) will
get a discount if it pays early. - For example, credit terms of 5/10 net 50 means
that if you pay in the first 10 days you only pay
95 of the bill or if you wait and pay in 50 days
the entire amount of the bill is due.
35Accounts Payable vs. Short-Term Debt - Continued
- So if you dont take the discount, you would in
effect be borrowing 95 and agree to payback
100, an interest rate of 5.26 (5/95) for 40
days (50-10). Assuming 365 days in a year, the
number of times 40 goes into 365 is 9.125 - The yearly interest rate would be (1.0526)9.125
-1 59.6
36Accounts Payable - Continued
- So take the discount even if short-term rates are
lower than 59.6 p.a.